The impact of institutional environment on the capital structure of firms during recent financial crises

• We evaluate the impact of recent financial crises on corporate capital structure.
• The level of debt issued by firms follows the exuberance of sovereign debt issues.
• The impact of institutional variables on leverage is inconclusive.
• Corporate leverage increases during periods of financial crisis.

This paper reviews the impact of institutional variables on the capital structure of firms during the recent financial crises (dot.com bubble, subprime crisis, and European sovereign debt crisis). For the first time, the general government gross debt and current account balance are included in the debate, revealing evidence that the irrational exuberance of sovereign debt has been mimicked by firms. The approach proposed reveals two important trends, broadly consistent throughout those episodes of disturbance. Under stress, firms increase leverage and then rely, or are forced to rely, on short-term borrowing, heightening rollover risks. Altogether, the outbreak of those crises sowed the seeds of a new one. Regarding the European sovereign debt crisis, the presence of an asymmetric shock has been noted, with the periphery and the center of the European Union being targeted to different extents. Lastly, it is clear that institutional variables are key to this topic and deserve a more careful analysis if we are to improve our understanding of the financing options available to firms, especially in times of financial crisis.